Mock 1

Q1)

Part a)

To: AI Powell, Audit engagement partner

From: Audit manager

Subject: Audit planning for Gruber co

Date: 1 July 20X5

Introduction:

These are the briefing notes for the audit planning of Gruber Co for the year ending 30 September 20X5.
These include specific matters to be considered of an initial audit engagement for audit strategy,
evaluation and prioritization of significant audit risks and specific procedures to be performed in respect
of Nakatomi building. These also include discussion and recommendation of ethical issues

Part a)

The chief executive holds 60% shares with remaining being split between his brother and sister. Most of
the internal operations would be in control of the family so they are less likely to identify mistakes in
each other’s work and may also result in collusion. Kali Hayes is only non family member but compared
to the rest his influence is insignificant.

Gruber co has 300 employees most of whom are mechanical engineers. The extent of auditor tools used
should be considered as engineering equipment would involve complexity. The use of auditor expert can
also be considered as that would help to verify the reasonableness of fair value of equipment used.

Initial discussion with potential acquirer for Martin’s share began last month. This is significant change in
management hence risk and audit plan should be revised according to it. Furthermore, window dressing
could also occur to show high value of shares to ensure sale of shares

The laws and regulations should be understood especially those relating to lease contracts. Most of the
buildings are on lease. The specific nature of requirements may cause delay which impedes operations
of the company. This show lacks control of most of the building so IFRS 16 would be relevant for them.
Experienced team members with knowledge of this ISA should be appointed

Part b)

Materiality:

The profit before tax has been selected as benchmark which ranges from 5% to 10% for the audit of
Gruber co it ranges from 0.7m to 0.14m. This is the first year of auditing entity so based on this basis risk
is high and lower range should be selected. Fair of investment property and intangible asset have been
determined by management and profit has been measured without using output method. The risk of
material misstatement is high so 0.7m should be materiality level

Fair value determined by Martin Gruber

The fair value of intangible assets purchased on March 20X5 should be determined based on method
prescribed by IFRS 13 based on level 1 or 2 inputs comparable to similar types of intangible assets.
Martin Gruber has estimates the value to be 9m as this is management estimate it could be biased. This
risk is high as no corroborating evidence in support of it was found. If estimate is biased then fair value
gain would be misstated. The 9m exceeds materiality level of 0.7m hence material

Argyle contract

The revenue and profit from Argyle contract should be recognized over time as manufacturing and
design would take 15 months to complete. As the policy of company the output methods should be used
with progress percentage calculated based on work certified to date 4m to total contract price 6m. This
would give progress percentage of 67% which should be applied on revenue with total costs of 2.6m
deducted to give profit. The profit of 2.2m taking account of this percentage would be 1.474. The CFO
believes it is appropriate to record full revenue because payment in advance has been received. This is
wrong accounting treatment as advance does not mean performance obligations of design and
manufacture have been satisfied which would take 15 months. If output method is not used then profit
and advance would be overstated by 0.726.This is material representing 5.1% of profit

Revenue recognition

The revenue from installation should be recognized immediately as performance obligation satisfied at
point in time when machinery is installed for customer. The revenue for the service contracts should be
recognized periodically for three years as customer annually receives benefit from the service fulfilling
performance obligation. There is a risk that management recognizes revenue from service contracts all
in first year. This is wrong accounting treatment as benefits are spread over three years and
performance obligation cannot be immediately satisfied in first year. If revenue is recognized
prematurely then it would be overstated. Revenue has increased by 15.3%

Johnson contract

Due to cost of inflation rather than generating a profit of 2.8m on contract to design and install
machinery for Johnson a loss of 840000 has been estimated. The provision should be made lower of
continued use and compensation if defaulted. There is no intention to abandon the contract so entire
loss of 840000 should be recognized. Management has recorded 700000 prorated for 10 months till 30
September 20X5. This is wrong accounting treatment as standard requires entire loss to be recognized it
does not state whether it should be prorated consequently loss has been understated by 140000.

Investment property

A retail development building has been purchased classified as investment property. The management
expert has estimated the increase in fair value to be 2m. Although it has been correctly transferred to
profit or loss the competence and independence of expert is uncertain. The estimation of fair value is
also inherently risk and involves judgment so if estimate is incorrect profit can be misstated

Financial analysis

Increase in revenue 15.3%

Increase in operating profit 80%
Increase in profit before tax 55%
Increase in total assets 90%

Commentary
Revenue has increased by 15.3% largely attributed to abandoning the output policy of company or early
recognition of three year service contract. The increase in operational profit of 80% is abnormal as sale
only increased by 15%. Even without the 2.2m profit wrongly recognized the increase is 58% for which
there is no explanation. Profit before tax increase of 55% is in line with operating profit if 2,2m is
removed otherwise trend is inconsistent. Total assets have increased almost 100% this is unlikely from
just intangible assets so management may have been biased in their estimates

Conclusion

The risk related to fair value of 9m for intangible assets should be prioritized is it highly exceeds
threshold of 0.7m and is management estimate. Then revenue recognition related to Argyle contract
should be recorded as it both material and management policy has been deliberately ignored by CFO

Part c)

1) Compare fair value of 17m resulting in gain of 2m with those of other retail properties and
market records to confirm whether estimate is biased or not
2) Develop independent auditor point estimate and compare it with 17m fair value of management
expert to verify whether the estimate is congruent with auditor’s business understanding
3) Appoint independent auditor estimate and compare the fair value determined by him and
management expert to verify which one represents most faithfully the value of building
4) Review published work and professional qualifications if any of management expert to confirm
competence and discuss whether he has any interest in client to confirm independence
5) Obtain written representation from management that all estimates are correct to confirm
whether IFRS 13 has been complied with

Part d)
Potential sale of Martin’s shares to Wills co would create conflict of interest as during due diligence
information related to Wills co existing audit client would have to be provided which would compromise
confidentiality principle

It should be considered that Wills co also require analysis of Gruber’s financial position resulting in
distribution of confidential information. The auditor must not favor either party and must remain
steadfast and honest. If one client is favored over the other then it would result in loss for the other
company

It should be revealed to both Martin and wills co that they are audit clients and the scope of the service
would require divulging confidential information. The disclosure can reduce the threat to acceptable
level as the auditor would be honest with them resulting in them searching for someone else

It should be evaluated that if due diligence service of both clients has to be done despite disclosure then
threat of conflict of interest would be too high hence engagement for one of the client would have to be
declined. It can be argued that if different teams provide due diligence for these two companies then
threat would be reduced. Quality review should also be conducted at year end

Wills co is already an existing client and the acquisition Martin share would ultimately be shown in
financial statements as associate representing 30% interest which would have to be audited by us
creating self review threat. This can be reduced by using different teams for both engagements

Q2

Part a)

The intended users of the report should be considered. The report is being prepared for assurance of
Morton’s Bank on whether to lend 15m loan or not. This restricts the liability of the auditor for only the
purpose of acquisition of loan. This would increase our confidence in providing loan.

The company has a foreign subsidiary in Netherlands which would result in foreign exchange differences
as both have different currencies. The estimates used in forecast should account for these changes such
as including payment at higher amount if it increases due to foreign differences. These may be omitted
to make forecast appear more reliable to bank

The ethical requirements of code of ethics must be complied with. The inclusion of former internal audit
team member, Mary sunshine creates familiarity and self review threat as she may be sympathetic to
her former colleagues and may fail to identify mistakes in her own work. The deadline is strict so she
may not be able to gather sufficient appropriate evidence in just 2 months

Her role in the audit team should be considered. This threat is significant as she has been appointed as
audit manager hence would have influence over the audit. Quality control review should be conducted
as any information from her would be unreliable to some degree such as she may not have provided
complete facts about material uncertainty paragraph for the year ended 31 march 20x5. For instance
she did not explain what liquidity problems and why disclosure was not made
The insistence of managing director of Flynn co for Mary co to remain part of the engagement team
raises concerns on the integrity of Mary. It could be that the managing director still has some influence
over Mary hence she should be removed from engagement team to eliminate this risk

Intimidation threat is created as management has suggested to Remove Roxie associated if favorable
report is provided to bank. If we do not comply they may threaten to remove us as well. Discussion
should be had with Roxie associates to ascertain whether they have faced any problems regarding the
material uncertainty last year. Those charged with governance should be informed to disclose material
uncertainty in financial statements otherwise we would not work for them next year

Part b)

(i)

Capital expenditure has remained constant at 7.5m from 31 Dec 20X5 to 30 June 20X6 and then no
expenditure has been incurred for the next 12 months. We should remain skeptical as maintenance
costs for the new facility purchased on 31 marches 20X6 may also occur to keep it in running conditions.
It seems this amount has been omitted

We should be skeptical as increase in operating expense is inconsistent with increase in sales. For
example sale increased by 8.6% from 31 Dec 20X6 to 30 June 20X7 where as costs increased only by
6.4%. The assumption that economies of scales would be achieved should be challenged as normally
losses occur in the first few years of business

Management believes that historical trend of cash received would be followed. This should be
challenged as due to start operations in Netherlands so it would be illogical to assume that customers
would follow the same pattern as local customers. Discounts may also be offered to increase receipt
which seem to have been omitted in forecast

The growth in monthly sales appears rather optimistic as management assumes that in the first six
months sales would increase from 0% to 17% on 30 June 20X6. This is unreasonable as there may be
competitors and other barriers of entries due to which such high sales may not be probable.
Furthermore, sales decline in following years for which the negative impacts seem to excluded

The assumption that products would be very popular should be challenged as customers may be more
loyal to local products. Furthermore sales have increased by 14% on 30 June 20X6. We should be
skeptical as corresponding marketing expense has not been conducted

(ii)

Specific procedures

1) Compare growth in sales of 17% from 31 December 20X5 to 30 June 20X6 with past trends and
market records of Netherlands to confirm reasonableness of assumptions as such high sales in
first month are rather optimistic
 2) Review market analysis and survey of market for demand of new product to confirm whether it
would be probable also inspect sales budget for increase in advertisement expense to
corroborate increase in sales as that has been omitted in forecast
3) Review breakup of operating costs from period 31 December 20X5 to 30 June 20X8 to confirm
that depreciation has been included as per increase in 10% capacity and new facility purchased
on 31 march 20X5. Also inspect cost of sales for any missing items
4) Inspect noncurrent asset schedule for inclusion of facility purchased on 31 march 20X5 and
maintenance schedule to verify whether any repair costs are expected and if so why have they
been omitted forecast
5) Discuss with management whether the increase in receivables would also increase bad debts.
Observe credit collection facility to confirm whether controls are strong or weak

General procedures

1) Recast the forecast to confirm accuracy

2) Confirm who prepared the forecast whether he is competent to prepare the forecast and
whether previous forecasts prepared by him were reliable by reviewing credentials
3) Confirm that accounting policies used in forecast are consistent with accounting policies used
overall by inspecting copy of policies or discussions
4) Review assumptions used in forecast whether they are consistent with auditor understanding of
the business
5) Verify the strength of controls in preparation of forecasts by observing them

Q3

Part a)

The receivable collection period has remained constant. This inconsistent with the fact that major
customer Cami has gain into liquidation hence it should have increased

The auditors have only reviewed the outstanding invoice and customer confirmations. While this would
confirm the amount of amount owned being 0.8m it is insufficient to confirm whether the amount had
actually been paid or not

Review bank statements to confirm whether amount was paid by Cami co also review Market records
and liquidation reports to verify if they are in any position to pay the loan. Discussion should also be had
with liquidator to confirm whether they would pay the amount in their behalf.

The basis for financial controller’s statement should be examined as he believes allowance should
decrease. Observe the controls to confirm their effectiveness. On sample basis compare ratio amounts
owed to amount received with previous year to verify whether assertion of finance controller is correct

The 0.5m is immaterial resulting no further work being performed. Although this is reasonable it does
not tell us whether this errors is also immaterial when aggregated with other misstatements hence
sufficient appropriate evidence has not been obtained
Record the 0.5m in schedule of uncorrected misstatements and compare the aggregate amount with
performance materiality to confirm whether amount is immaterial in aggregate. The performance
materiality would be lower than actual level to identify such misstatements

The % of write downs for inventory has increased from 5 to 10%. This is unusual as the JIT system was
expected to lower the number of obsolete inventory or reduce it to 0. The inexperience of management
should not undermine the effectiveness of system so it can be argued that actual results should be
showed

Similar to issue with allowance the 0.4m is not aggregated with other misstatements to confirm whether
they are collectively immaterial. Once aggregated they become 0.9m which is still lower than 1.25m
materiality level but comparison should be made performance materiality which is 75% of 1.25m
resulting 0.93m almost equal to it hence management should adjust it

The 15 inventory holding days is lower than 20 days expected hence trend is inconsistent. The
production cycle of supplier should be observed to confirm placement of order is after one week

The terms of customer contracts were observed which corroborate reduction of 5 days in inventory
holding period. Although this corroborate the statement this does not show whether goods were
actually received in that period or not

Review GRNs on sample basis and compare them with sales order to firm they are delivered within 10
working days as any fluctuation could suggest that management is placing too much reliance on system
that is generating false results

The attendance in inventory count and sample counts only confirms the amount of the inventory. It
does not confirm whether completeness of inventory in financial statements as it can differ from
inventory sheets

The amount from inventory sheets should be compared with financial statements to confirm all items
are recorded as management may understate it

Part b)

Government grant
The error in government amounting to 5m represents 11.6% of profit before tax hence is material to
financial statements

Government grant acquired on 31 December 20X4 should be recognized for 3 months only till year end
31 March 20X5. Management has recognized the full amount. This is wrong accounting treatment as
deferred income should be recognized systemically. Due early recognition deferred income has been
understated and revenue overstated

The government grant should be recognized when condition for grant is fulfilled. Grant has been
recognized despite condition not being satisfied which is wrong treatment. This should be discussed
with TCWG as no evidence of condition being satisfied by 30 September 20X5 have been provided other
than verbal evidence of fiancé director

The misstatement is material hence qualified opinion would be expressed. The opinion paragraph would
be changed to qualified opinion and basis for qualified opinion would explain nature of misstatement

Machinery sale

The actual sale proceeds obtained on 31 March 20X6 should be 9m whereas management has
recognized 10m. It should be discussed with management to correct this misstatement then
subsequently review the adjustment

The cost of capital 10% should be appropriate for discount based on market rates. The appropriateness
has been confirmed which confirms that amount calculated by auditor is correct. It should be discussed
with management why they did not discount 10m using this interest rate

The 1m overstatement represents 2.3% of profit before tax hence should be compared with
performance materiality to confirm whether it is also immaterial in aggregate

If misstatement turns out to be material in aggregate then qualified opinion would be expressed with
basis for qualified opinion explaining nature of misstatement. If immaterial then unmodified opinion
would be expressed